Costing a 2/10 Net 60 Discount and a Reverse Factoring Programme at 2.85x Leverage
A listed FMCG company reports DSO of 94 days, DIO of 71 days and DPO of 38 days on annual revenue of PKR 48 billion and COGS of PKR 33 billion. Its average borrowing cost is 17% per annum (3-month KIBOR plus 350bp) and it is close to its net debt/EBITDA covenant of 3.0x, currently at 2.85x. The commercial director proposes offering customers 2/10, net 60, expecting about 35% of revenue to be invoiced on those terms; he argues the discount is 'cheap' relative to the 17% cost of borrowing. Separately, a bank offers a reverse factoring programme for the company's 40 largest suppliers: the bank pays suppliers at day 30 and the company pays the bank at day 90, with the bank charging the company 13% for the extra 60 days. The CFO wants to extend DPO without hurting supplier relationships and without breaching covenants.
1. Compute the cash conversion cycle and the cash released by a 10-day improvement in each component. Then evaluate the 2/10 net 60 proposal with numbers.
Read the worked answer
CCC = 94 + 71 − 38 = 127 days.
Cash released per day of improvement
- DSO: PKR 48bn / 365 = PKR 131.5m per day
- DIO and DPO: PKR 33bn / 365 = PKR 90.4m per day
A 10-day gain on each releases 1.32bn + 0.90bn + 0.90bn ≈ PKR 3.12bn, taking CCC to 97 days.
The discount - the average test is the wrong test
Cost of forgoing the discount = (2/98) × (365/50) = 14.9% p.a., below the 17% borrowing cost, which is where the commercial director stops. The right question is which payers actually switch:
- A customer now paying at day 94 who moves to day 10 gives the company 84 days of funding worth 17% × 84/365 = 3.9% of the invoice for a 2% discount - clearly value-accretive.
- A customer already paying at day 45 gains only 35 days ≈ 1.6% - a straight loss, and a windfall for a payer who was never the problem.
At 35% take-up, the DSO effect ranges from about 29 days (if all takers were 94-day payers) to about 17 days (if they were 60-day payers) - worth roughly PKR 3.9bn to PKR 2.3bn of cash. But the P&L outcome flips from a net gain of ~0.7% to a net loss of ~0.4% of revenue purely on payer mix. Also note the discount reduces the transaction price under IFRS 15 - it is a price cut, not a financing cost, and it re-prices the whole customer menu.
2. Evaluate the reverse factoring programme: cost, accounting substance, covenant impact, and the ethics of supplier pressure.
Read the worked answer
Cost. 13% p.a. for 60 additional days = 2.14% per cycle on the payable, versus 17% on an overdraft. Extending DPO from 38 to about 90 days releases roughly PKR 90.4m × 52 ≈ PKR 4.7bn. On pure cost it beats the overdraft.
Accounting substance - the decisive issue.
- If the bank has recourse to the company and the terms materially extend beyond normal commercial terms for that supplier base, the balance is a financial liability, not a trade payable. It will be reclassified as borrowing and treated as debt by rating agencies.
- At 2.85x against a 3.0x covenant, that reclassification is not a presentation nicety; it can be the breach. Agree the treatment with the auditors and, if material, with lenders before signing.
- Presenting it as payables while it functions as debt is the ethical failure mode - disclose the programme, its size and its tenor.
Who bears the 13%. If it is charged to suppliers, the company is monetising its balance-sheet strength. Suppliers will recover the cost through price at the next negotiation, so the saving is partly illusory and the relationship cost is real. If the company pays, it is simply borrowing at 13% - which is still better than 17%, but it is borrowing.
Concentration. One bank now sits inside the supply chain for 40 suppliers. If the programme is pulled, all 40 are exposed simultaneously; that is a new operational risk that must appear on the risk register.
Recommendation: use it selectively for strategic suppliers where the all-in price is neutral, classify honestly, pre-clear covenant treatment, and ring-fence the facility with a documented exit plan.